India secondaries: Much heat, little light

India has all the ingredients to become an active market for spin-outs of existing private equity portfolios by secondary investors: GPs invested a huge amount of capital between 2006 and 2008 but have yet to see a similar magnitude in exits; increasingly disillusioned LPs are clamoring for distributions and holding off on commitments to new funds until they see some.

Nevertheless, Lightbox remains an anomaly. With Kleiner Perkins Caufeild & Byers (KPCB) and Sherpalo Ventures looking to pull the plug on their India joint venture, the local team spun out. In October they announced that several secondary specialists had supported an acquisition of six existing portfolio companies, while a separate group of LPs provided $100 million for new investments.

Prashant Mehta, a partner at Lightbox, describes the fundraising process as reasonably straightforward. On the secondary side, he believes it helped that the investors knew what they were getting.

"In most cases, what happens with secondaries is you try and buy a portfolio or a company that you haven't driven," Prashant says. "We were already running the portfolio so it was more a financial transaction. There is really no difference in terms of the board, just the shareholding. It made for a smoother situation."

Anecdotal evidence suggests there is no shortage of zombie funds in India; the manager has lost interest, perhaps recognizing there will be no successor vehicle, and the LPs want to get out. There are also GPs that want to remain in business and need replacement LPs to help reinvigorate a portfolio. But secondary deal flow is not meeting expectations.

"I would love to do a deal in India right now because I think the environment is going to be better than it has been in the last four years, but the challenge is finding the right opportunities," says Tim Flower, managing director at HarbourVest Partners. "There are only a handful of high quality funds and then pricing expectations make it quite hard to find an entry point."

Crossing the void

Pricing is a longstanding gripe among secondary investors. Spinning out a portfolio can be complicated by the GP or LPs asking for valuations that secondary players see as unrealistic. In the case of Lightbox, there were only two major LPs, both of which wanted to exit, and this made negotiations easier.

Lucian Wu, a managing director at Auda, describes India a mixed bag, with GP volatility creating secondary opportunities of the traditional and the direct variety. He sees valuations as a major concern for primary players but this does not exclude a secondary angle where investors could "have a second bite of the cherry at a decent price."

The situation has arguably changed in recent months on the back of positive investor sentiment that greeted the election of Prime Minister Narendra Modi. Public markets have shot up and so have GPs' assessments of assets that 12 months earlier might have been perceived as near toxic. Portfolio companies still need to be sold but there is the possibility of tapping the public markets at a valuation that means they are no longer underwater. GPs are no longer faced with a choice between a secondary sale and continued illiquidity.

India PE exits stand at $4.2 billion so far this year, lower than the 2013 total, but a slowdown in trade sales has been in part offset by a surge in public market transactions. There has yet to be a surge in IPOs - there have been three PE-backed offerings in 2014 - but momentum is expected to gather. Of the 16 companies that have submitted draft red herring prospectuses since April, eight have private equity investors.

Secondary exits to other GPs have gained traction in recent years: annual deal flow didn't surpass $400 million until 2010, and then stormed past $1.5 billion in each of 2012 and 2013. There have around 20 transactions this year, the same as 2013, but the cumulative value has dropped by more than half to $692 million.

Amit Gupta, a partner at NewQuest Capital Partners, which specializes in direct secondary acquisitions of single assets or portfolios from GPs, is not disheartened by the changing circumstances. While he accepts that the strong public markets will reignite GPs' IPO ambitions, there are still managers who are uncomfortable playing the waiting game. They don't know if and when the market might weaken, so any liquidity is welcome.

Furthermore, some private equity firms are looking to capitalize on the more favorable investor sentiment towards India and raise fresh capital. A secondary sale could facilitate this process.

"What has changed most is the hope - people think they can raise new funds so it makes sense for them to create distributions to paid-in (DPI)," Gupta says. "Pricing expectations are within a much narrower range than a year ago and we have started to receive more reverse solicitations."

Just under $2.4 billion has been raised for India-focused funds so far in 2014, bettering the full-year number for 2013, although still some way short of the 2008 peak of $9.4 billion. However, at least seven high-profile domestic GPs are either in the market or about to enter it, seeking to commitments of around $3 billion between them. In some cases, exits are somewhat thin on the ground, so why wouldn't these GPs explore their secondary options?

According to one industry participant, these firms are conscious of the need to deliver liquidity to LPs but wary of secondary solutions. Their approach is described as opportunistic - one eye remains on the IPO market but they like to know how much they could get for assets through secondary sales.

State of flux

This constant state of flux bears similarities to the experiences of a number of investors who claim to have looked at Lightbox once it became apparent that KPCB and Sherpalo wanted out. They say their interest cooled as the composition of the portfolio changed.

First, Cleartrip Travel Services, operator of travel booking site Cleartrip.com, was sold to US-listed Concur Technologies, a business travel and expense management services provider. Then it was decided that mobile advertising network InMobi would remain as part of the KPCB-Sherpalo portfolio. Lightbox retains well-regarded refurbished electronics retailer Greendust, but for some this was not enough.

Avenue Capital Group has followed the same path. A handful of India portfolio companies were available, first with a management team attached and then without. The star asset was hospital operator Global Health Private. Last year, Avenue sold its minority stake in the business to The Carlyle Group for around $150 million; a secondary transaction but not one that benefited investors looking at the entire portfolio.

The PE firm saw a return on its investment of more than 4x, but the price secondary specialists were willing to pay for the remainder of the portfolio fell accordingly. While this is not a rare occurrence - for many GPs, a secondary sale is Plan B, and rightly so in some cases - it can create problems down the line.

"Part of the appeal of working with HarbourVest is we can assist with tail end portfolios. You are getting rid of the good, the bad and the ugly, but you need to keep it together. If the seller limits the portfolio to only 1-2 value drivers, the buyer's valuation is unlikely to meet seller expectations, whereas a larger portfolio offer more opportunities for upside and pricing flexibility," says HarbourVest's Flower.

Secondary investors might not be finding deals on terms they find acceptable, but at the same time the current public markets buoyancy is unlikely to last forever. The vast majority of investments awaiting exit are minority interests in companies, which means the private equity firm is not in control of its own destiny. A drop in the market may make them think once more about secondary solutions.

"There is a very large, almost completely non-crystallized opportunity in the medium term. The reality has not set in yet - people are still claiming management fees and hoping the Modi bounce will get them out of investments that really are not very good," says Doug Coulter, head of Asian private equity at LGT Capital Partners. "It might not be a tsunami but there will be an opportunity."

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• Topics
• Secondaries
• Secondaries
• South Asia
• Buyouts
• buyout
• Secondaries
• India
• HarbourVest Partners
• NewQuest Capital Partners
• Auda International
• LGT Capital Partners